How to Sell Credit Spreads

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Selling credit spreads: Today, we’re going to go over all of the trades that we made, both Thursday and Friday this week and round out some of the trades that we had for expiration. Right inside the membership area, you can see the new trading alert page that we have that we’re linking to in this video.

And we had a couple of opening trades and one opening trade on Thursday that I wanted to go over, and then everything else is pretty much from Friday. The first one that we’re going to go over is an EWW trade. And since we have only had one trade on Thursday, I just want to cover this one real quick as part of Friday's video instead of making two different videos for it.

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How to Sell Credit Spreads

In EWW, we just saw an opportunity to add some more premium as the market is starting to rally and a lot of things are gathering. But we wanted to go ahead and add some negative Deltas to our portfolio, meaning that we want to go bearish on EWW. I think the recent bounce has been okay in Mexico, but I don't believe that it's going to last too much longer, so we just saw an opportunity to possibly sell some premium.

We went ahead and did the January 62/64 call spread for about $.30 in credit, so that puts our breakeven price around 62.30 for EWW in January. Here’s a look at the chart here. And you can see that implied volatility has spiked up in this ETF. And with our breakeven price, it allowed us to move our strikes up to about 62.30 for EWW, so really good pricing on this trade, it also gives us a lot of room for Mexico and this particular ETF to continue to rally and we could still make money because EWW can rally even higher to 62 and we still make money, or it could stay flat, or it could obviously go lower.

But all we’re looking for is that drop in implied volatility which we started to get already, but if we can continue to see a drop in implied volatility, that would help solidify this position. As far as pricing goes, here are the January options that we have, and you can see that we started at about the 18% probability level.

That first strike that we sold, there’s about an 18.85% chance that EWW goes from where it’s at now and closes above 62 by expiration. What this means is that we've got about an 80% chance of winning on this trade and about a 20% chance of losing. We still kept it small as always, but this is a classic example of a high probability credit spread trade.

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Alright, the other trades that we’re going to go over today, we did get into more of IWM. We had a nice month trading IWM last month and made our custom trade in IWM, that custom naked position. And what we want to do this month is go ahead and just add some more premium. This time, we did all the way out to February. We did the 106/108 put spread for $.25, so trying to be non-directional in all areas.

We've added a QQQ call spread before, and so we wanted to add IWM because if the market does continue to rally, we want some positions that are going to make money with that market rally, so we did the 108/106 credit put spread in IWM for February. As we look at the trade tab here of IWM, you can see we tried to be very high probability about how we’re making this trade in February, and we decided to go ahead and do the 108/106 put spread below the market, so at that 15% probability level for that 106 strike being hit.

What that means is that the likelihood that IWM goes down and closes below 108 is about 15%, so we’ve got a trade here that’s about an 85% chance of success, it's obviously a little bit of a credit, so you don’t get a lot as far as a credit is concerned, you only get about $25 for the one spread. But this is what high probability trading is about. It’s about taking in small credits and making the odds work in your favor long-term.

We also did an iron condor in AMZN which is Amazon. I like this trade because I think the pricing was pretty good in Amazon and it popped up on our radar to have high implied volatility. We went ahead and did the January options because they are very liquid, we didn’t even need to go out to February. We did the 325/330 call spread, so selling the 325, buying the 330 on the call side, and then the 265/260 put spread, so we sold the 265 and bought the lower strike 260 put spread to take in a credit on Amazon.

Because the width of the strikes on those is $5, we’re putting up about $400 of capital to risk, about $100 of capital for the Amazon trade. And let me just bring up the Amazon chart as well, so you guys can see this. Alright, here’s the chart of Amazon and you can see that the stock has had a tough time as we headed towards December expiration, but I think we settled into a little bit of a range here. And implied volatility has already started to drop, but it was above that 50th percentile when we entered this trade.

Now, with our strikes that we selected, we went neutral around where Amazon is trading right now, so we are not taking too much of a directional bet, either way, we’re trying to be relatively neutral on our direction. And you can see on the topside of the trade, so we’ll look at the topside here, the probability that Amazon gets to our top strike at 325 is about 20%, and because they’ve shifted today with the market open, the likelihood that Amazon gets down to our bottom strike, all the way down here at 265 is about 7%.

Those were even at about 15%, but we’ve already had a move up in Amazon over the last day, so that’s obviously affected the position. And what we can do here if we get a continued move higher in Amazon is take this put spread and roll this put spread closer to the market. We talked about that inside the platform here in the video tutorial section for a trade alert, talk about the mechanics of actually rolling that spread closer. But that’s something that we can do for sure if we start to get tested on Amazon, but I still really, really like this trade going forward.

Okay, a couple of trades just that expired today, ANF which was an excellent trade, a trade that we’ve held all the way since earnings. In Abercrombie and Fitch, all five of our iron condors in ANF have expired, so we took in a nice $115 profit on that trade. GLD, we’re going to be doing a pretty big case study on GLD that we had three iron condors. And I didn’t put up any of the strikes because this was an iron condor that we’ve legged into a couple of times.

And we had so many different strikes, but it was a trade that we made adjustments to and increased our potential profit in this trade by adding those changes. Over the original position that we had, by adding those adjustments to the position, we increased the profit in the trade. It’s going to be an interesting case study and we’ll be posting that inside the platform.

And then FXE, all of our iron condors in FXE that were left expired worthless at the end of the month too. After all adjustments that we made in FXE because FXE did actually go against us, this is another one that we’ll be doing a kind of interesting case study on, take a look at a stock that goes against us just outside of the range that we needed, but after we had made adjustments, we were able to make a nice $56 profit.

It wasn't a huge winner, but it could’ve been a loser had we done nothing on the trade, so a good example of how we're managing the winners there. Alright! As always, I hope you guys enjoy these videos, and if you have any comments or questions, please add them right below in the membership section. And until next time, happy trading!

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. In 2018, Option Alpha hit the Inc. 500 list at #215 as one of the fastest growing private companies in the US. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and three children.